Many people look at Intel, or another wildly successfully company, as justification for a concentrated stock position. By the time of its IPO, an investment in Intel founder’s stock would have returned $2170 for each dollar invested. A fantastic result that fulfilled co-founder Robert Noyce’s vision that all Intel employees, from executives all the way down, would share in the success of the company. And even employees joining later were lucky enough to share in the remarkable growth of the company as Intel’s stock returned more than 23% compounded annually over the first twenty years post-IPO—turning just one dollar into $670.
Examples like this—and other well know success stories like Apple, Microsoft, Google, Facebook, Tesla, etc.—make investments in individual company stock seem compelling. However, from an investment perspective it rarely, if ever, make sense to hold a concentrated position.
The Risks of a Concentrated Stock Position
JP Morgan conducted a study (pdf here) of concentrated stock positions from 1980 through 2014 and concluded with the following: “Over the long run, some companies substantially outperform the broad market and maintain their value. However, the odds have been stacked against the average concentrated holder.”
The key findings are summarized below:
- Since 1980, roughly 40% of all stocks have suffered a permanent 70%+ decline from their peak value. For Technology, Biotech and Metals & Mining, the numbers were considerably higher.
- The return on the median stock since its inception vs. an investment in the Russell 3000 Index was -54%.
- Two-thirds of all stocks underperformed vs. the Russell 3000 Index, and for 40% of all stocks, their absolute returns were negative.
Investing in individual stocks is quite risky. Instead of a 50/50 chance of whatever stock you are holding outperforming, the likelihood of this happening is actually much lower, just 33%. And why is this? A few positive outliers significantly improve the index returns.
Companies, like Intel and other famous success stories, are the “extreme winners” in which investors in a diversified index are guaranteed to participate in the success. By holding individual stocks, you are actually much more likely to miss out on these “extreme winners” than someone taking a diversified approach.
I recently read The Intel Trinity, a history of the company through the eyes of the “Big Three” (Robert Noyce, Gordon Moore, and Andy Grove). And what struck me is just how perilously close even the successful companies are to failure. It’s impossible to predict ahead of time who the winners will be and who will fall on the scrap heap of history.
Even Intel, which from its founding was regarded as having the best leadership and technological expertise in Silicon Valley, wasn’t a sure-fire investment. The company had to overcome many obstacles and competitive threats to become the company, and fabulous investment, it was. Despite all the talent, the intelligence, and smart strategic decisions, and on top of the blood, sweat, and tears that every employee put into the company, even Intel needed a bit a good luck to end up an “extreme winner.”
Consider the remarkable story of Intel’s Operation Crush and how in the late 70’s Intel overcame “the biggest existential threat the company faced in its decade of existence.” [All quotes from the highly recommended book The Intel Trinity by Michel Malone.]
In mid-1978, Intel released the Model 8086 16-bit microprocessor. The 8086 was “the first true single-chip microprocessor…[and] its architecture would prove to be the defining standard of generations of processors that dominate the digital world to this day.”
The release had Intel’s competitors reeling, but not for long. Within six months Motorola came out with its 16-bit microprocessor—the Model 68000. And “the 68000 was a masterpiece, one of the greatest microprocessors ever designed.” But Motorola wasn’t the only competitor. Zilog, led by former Intel scientist and the inventor of the microprocessor itself, Frederico Faggin, was working on the development of its 16-bit processor, the Z8000.
At this point, according to Intel’s microprocessor director Bill Davidow, “There were three of us in the race: Motorola was going to be first, Zilog second, and Intel was headed for obscurity.”
With the stakes clear, Intel set out not just to survive but to dominate Motorola. And to do this, it needed “design wins.” The wins were so important as they resulted in not only a short-term increase in revenue but also a long-term customer relationship. “Once a company designed a particular microprocessor into its new product, it was wary of replacing that chip in future versions. …Thus, a single design win might result in renewed contracts for years, even decades.”
Enter Operation Crush.
The first task was to set sales quotas, initially set at a reasonable sounding one win per salesman per month. Only afterward did someone bother to check the math. Hitting the quota “would mean Intel would have to land two thousand design wins by the end of 1980. That was an insane number.” Most analysts were predicting roughly a third of this total.
But, “in one of the most important decisions in company history, the marketing team voted to stick with the original number.”
The goal now set, Intel still needed to figure out how to get the wins. In purely technical terms, it still had an inferior product to Motorola and Zilog. To solve this problem, “Davidow and his team managed to put themselves into the shoes of their customers and finally began to appreciate the fear of the unknown those customers were feeling and their desperate need to be protected from making suicidal technical decisions…What Intel’s customers really wanted was a solution,” not a product.
Intel took inventory and listed its “extras” or strengths versus its competitors. Reputation, pedigree, a company of specialists, and a collection of tools available to the customer all set Intel apart. Combining these into an “overarching solution” Intel launched Operation Crush, which was designed to place Intel and its Model 8086 as a complete solution, not a stand alone product. And the plan worked.
Soon after, Motorola, panicked by Intel’s new strategy tried to mimic it. According to Davidow, “Had Motorola chosen to remain aloof from our challenge, I think Intel would have been in deep trouble.” And according to Malone, “no company ever held such a strong position and then destroyed itself so completely in the face of a weaker opponent.”
Intel had crushed Motorola but hadn’t yet dealt the death blow to the industry.
Enter field sales engineer Earl Whetstone. Confident and hungry to fulfill his sales quotas, Whetstone approached “the unlikeliest whale of them all: IBM Corporation.” And his timing was fortuitous. Unknown to him IBM was operating a small skunkworks operation that would eventually become the IBM PC personal computer, “one of the most successful electronic products in history.” And for the project IBM was willing to break “precedent and…go outside the company for components, parts, and eventually software.”
Whetstone got the design win, but no one appreciated yet how much it mattered. Gordon Moore: “Any design win at IBM was a big deal, but I certainly didn’t recognize that this was more important than the others. And I don’t think anyone else did either.”
IBM still needed the software for its PC and approached a young Bill Gates about his word processor software and asked for a recommendation on a good operating system. Gates recommended DR-DOS, created by Digital Research. “When negotiations collapsed, [with DR] IBM came back to Gates and asked Microsoft to develop a comparable operating system.” Gates and Microsoft developed MS-DOS for IBM. Then, in likely the most important decision of all for Intel, IBM allowed both the cloning and sale of MS-DOS to other computer makers. “It was a brilliant stroke. Soon the market was filled with PC clones,” all running on MS-DOS and Intel chips. “Apple computer which had held as much as 90 percent of the personal computer market” saw its market share drop to the single digits over the decade.
No one could have predicted it, and even those involved didn’t know it at the time, but “Intel’s sale of the 8088 to IBM to become the central processor unit of the PC signaled the end of the microprocessor wars almost before they began, with Intel the clear and dominant winner.”
Return on Luck
Jim Collins in his book Great By Choice uses the term “Return on Luck.” His point is that every company will get some luck along the way, the great ones capitalize on these opportunities. Intel did this better than most. But as investors, it’s next to impossible to predict which companies will get how much luck and which will capitalize on it.
To me Operation Cush, and stories like it, highlight the incredible amount of things that must go right for a company to be wildly successful and how perilous Intel, or Microsoft, were to not becoming the success stories and “extreme winners” that we know them to be today.
While the companies that grow into massively transformative businesses and fabulous investments might look clear in hindsight, and they are no doubt exciting to be involved with at the time, it’s no way to invest.
Instead of putting your future wealth on the line, a better strategy is to diversify and never miss an “extreme winner” again.
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Cordant, Inc. is not affiliated or associated with, or endorsed by, Intel.